Technical SetUps

Technical Setup: Small Caps

One of the most hard hit sectors during the 2020 crash has been small caps. Absolutely decimated during the crash giving up half of its gains since the 2009 lows off of the 2018 highs. Long a concern in 2019 for its lagging performance versus the rest of the market small caps never made new highs in 2019 or 2020.

And now the bottom has fallen out. Even during last week’s market retrace small caps were leading the downside.

Yes despite the weakness a technicals setup was building from the bullish side which was interesting even during the pronounced weakness so it’s something we tracked:

Specifically we tracked the pattern of a falling bullish wedge last week:

This tag of the lower trend line on April 2nd suggested this trend line was technically relevant, especially considering it produced a sizable bounce initially:

But there was also good reason to be cautious still as the pattern still had room lower and no breakout was confirmed.

Indeed the pattern extended lower again on April 3rd:

But then the pattern looked to break to the downside, but that break was saved and we saw a solid bounce off of the trend line again confirming its relevance.

Risk of course referring to the recent unpredictability in regards to market gaps.

But the analytical view was building that this pattern would break to the upside.

And it did: With today’s massive gap up above the wedge confirming the pattern and producing an over 8% move from the lower trend line tag:

Does this bullish turn imply a broader turn for small caps? The technical pattern above is based on a short term chart and it highlights nicely how technical patterns can be used to identify risk versus reward. As a short term pattern is may have little predictive value for future returns, however the broader context may matter .

Why? Because looking at a monthly chart last week’s bullish pattern forming amid pronounced weakness highlights several important technical observations:

First off recognize that between the 2009 lows and the 2018 highs small caps have created a curious set of fib alignments. With the 2018 highs key price levels have aligned with previous key support and resistance zones (see the 236 fib, the .382 fib and the .50 price pivot. The recent March lows pierced below the .50% price retrace area, but that pierce below the .50 retrace zone was saved by the end of March. Now the retrace of that bounce rally into the end of March last week has now defended that .50 price retrace nearly perfectly and has now bounced from there.

This back to back action affirms the .50 price retrace zone as support.

Furthermore it opens the potential of this being a monthly double bottom for the here and now. In addition, we can note that small caps remain outside their monthly Bollinger band. It is extremely rare, or rather unheard of, to see price extended this far below a monthly Bollinger band (currently at 1216) for an extended period of time. If anything seeing price inside the monthly Bollinger band is the norm.

This index here remains therefore technically imbalanced for that very reason.

Also of note is the monthly 5 EMA now at 1322 and declining. Such a wide disconnect is also highly unusual and reeks of imbalance.

Bottomline: Should market stabilize further into April small caps have a shot at seeking technical rebalancing at higher levels from here still. Whether such a rebalancing marks a firm bottom for markets will then still be a totally separate discussion. But for now it’s a working long technical setup and the falling bullish wedge that formed last week gave the heads-up.

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Categories: Technical SetUps

10 replies »

  1. I gotta say: Stating things I didn’t say makes me think you have no clue how to read.

    I stated: “opens the potential of this being a monthly double bottom for the here and now”. I did not state “the bottom”.

    Furthermore I stated for all to read: “Whether such a rebalancing marks a firm bottom for markets will then still be a totally separate discussion”.

    Good Lord.

    • Dear lord! Technicals are meant for trading or to infer strategic opportunities to lower/increase risk…they’re not meant to “predict” outcomes for clout. It’s a game of odds and probabilities. Go follow someone who thinks they know everything and enjoy losing your money on that one massive prediction failure you went all in on…ffs!

  2. good on ya Sven 🙂 can Kevinm76 say that the Fed had similar policies around 2000 and 2008? did the Fed go nuclear back then? No one has called a bottom here – but what if the Fed continues to go nuclear????? what if oil has some miraculous intervention we don’t even know about and virus clears? answer that Kev? obviously at the moment markets are being manipulated more than during the trade war and I find it laughable really that Trump can still blurt this and that and it’s a buy. But markets don’t give a s..t. Give me Fed money…….

  3. Kevin M, in Sven’s defense… At no point during my reading of this post did I interpret Sven’s message to mean “bottom reached in Small Caps”. Instead, he was clearly suggesting that the Russell 2000 (IWM) was way oversold and due for a STRONG BOUNCE. Whether lasting or dead-cat, that remains to be seen.

    Perhaps give it a 2nd read.

  4. Kevin, please post a link to the article you read so I can contrast it against Sven’s piece above. Thanks in advance for a friend.

  5. Russell 2000 is heavily junk rated debt companies and the Fed is buying JNK, so maybe you’ll see a strong bounce. You need inflation to get the IWM to really move. That’s not on the immediate horizon.

    I would suggest most investors stay on the sidelines or in unleveraged 1/5 standard trading lots – this market is only one headline away from self destruction. What happened with Boris Johnson could happen in the good old USA as well.

      • Thanks for the clarification, but I think they started to buy JNK today. Quite frankly I always assumed they would in short order.

        The current Fed intervention is beginning to resemble one of Trump’s monstrous gilded, gaudy, Romanesque hotels. But congratulations to Sven for pointing out we may be going to 2900 on the S&P.

        You won’t know the Fed is buying stocks until the S&P hits 3000, then they’ll make the announcement and it will fly to 3300! So, buying gold seems to be the only prudent short term bet, although gold does not like recessions, and one is coming.


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